HESA

Higher Education Strategy Associates

Income-Contingent Loan Problems

Everyone who’s ever given thought to the matter thinks that income-contingent loans are superior to mortgage-style loans.  At any given level of debt, it’s always preferable for low-income borrowers in repayment to have the option to suspend payments, and make them up at a later time.  Pretty much all the objections to income-contingency – especially here in Canada – are about matters extraneous to the actual method of loan repayment (e.g. fees would rise, interest is too high, etc.).

The reason that income-contingent loans work for borrowers is that they operate on the principle of, “can’t pay today?  No worries, catch you tomorrow”.  On average, that’s true: where students have low-income early in their repayment period, their incomes later on usually rise sufficiently to pay off the debt without difficulty.  The problem is that while this is true on average, it’s not true for everyone.  And that means loan losses. While losses are part and parcel of any publicly subsidized loan system, at least with “regular loans” you can see those losses more or less as they occur, and can make provisions for them on that basis.

But the Australian Higher Education Contribution Scheme (HECS), and its English counterpart, basically assumed away the problem of losses (no worries, catch you tomorrow).  That led them to do a lot of really dumb things with respect to loan repayment thresholds.  In both countries, when tuition fee increases were in the offing, governments tried to calm students by offering them breaks on repayment terms: in Australia, “no repayment” now occurs below A$51K in annual income; in England, the threshold rose from £10K in 1998 to £15K in 2005, to £21K in 2012.  And each time it rises, a few more borrowers became less likely to repay the full value of their loan.

The problem is that, eventually, tomorrow arrives.  In Australia, of the $25 billion that has been issued in HECS debt, $6 billion has been written-off – that’s up from just $2 billion in 2006 (and that’s in addition to billions in loan interest subsidies).  In England, they’re so worried about the long-term costs of non-repayment that they’ve effectively halted any growth in enrolments, so that the loan portfolio doesn’t get any bigger.

None of this is really the “fault” of income-contingency, per se.  It’s more the fault of deliberately setting repayment thresholds at levels where poorer graduates won’t repay; lower the threshold and the problem goes away.  It’s not even really clear that it’s a problem – ensuring that the poorest graduates don’t repay their loans is arguably a pretty sensible subsidy.

But there’s still a public policy failure here.  Governments lost control of part of the education budget because the “catch you tomorrow” attitude meant there was no default mechanism to tell them when things were going wrong.  And that actually is a problem with income-contingency – and future loan program designers need to consider it carefully.

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